Henry Schein, Inc. (HSIC) Earnings Call Transcript & Summary

Hi. Good morning. Good morning, everybody. My name is Erin Wright, I'm the lead healthcare services analyst at Morgan Stanley. We're happy to have with us today, Henry Schein and the management team. So we have Stanley Bergman, Chairman and CEO; as well as Ron South, Senior Vice President and CFO. We also have Graham Stanley in the audience from an IR perspective. And yes, thank you so much for coming. I really appreciate it. I think you would like to make some opening remarks, if you would like, or we can jump right into questions either way.

I can make opening remarks. I'll make them very briefly, Erin, and then you can ask your questions. I think that's probably more interesting. I think investors know Henry Schein is the largest provider of products and related services to office-based practitioners. 2/3 of our business is in the dental and related space and around 30% or so of our business is in the alternate care space, namely that part of the market that serves patients outside of acute care setting and outside of the drug store. It's growing as patients move from the acute care setting into the alternate care setting, and we recently added a significant component of home care products and related services. The dental markets are relatively stable. Globally, dentists are investing in their practices. There is a slight pressure on high-end dentistry in some parts of the world, not significant, but there is. And the shortage of staff that's been written about is really a U.S. phenomenon, primarily related to dental hygienists. Dental practices are busy. And generally, we're advancing our strategic plan. We call it internally BOLD+1, building our high-growth, high-margin businesses; operationalizing and optimizing our global distribution businesses; and leveraging our 1 million customers, 1.5 million practitioners. They buy from one part of the business. We'd like them to buy from another, driving share of wallet. And our D is our advancing of our digital strategy, [ Happy ], and to talk about that, we're investing heavily in the digital space as practitioners visualize their practice. And then the +1 is we're highly committed as a company to a purpose of aligning with the needs of all of our constituents, our suppliers, our customers, our team, investors and society in general. So that's a bit of a quick recap on Henry Schein. And we've had consistent growth in the 28 years that we've been public in the high single digits, low double digits EPS growth, and we turn our profits into cash.

Great. Thanks. Can you comment a little bit about just broader dental demand trends? I think you mentioned in your remarks there that it's relatively stable. But can you break down what you're seeing across the U.S. as well as internationally and how those trended year-to-date? How are you thinking about it going into the back half of '23, too?

Yes. In U.S., in fact, the North American market is -- there are more procedures being undertaken. And before COVID, not in every part of the country, some parts of the country, some parts of North America, there's more procedures. Some parts, less. It's actually where the demographics are growing. You'll find more. But it's quite stable and leaning in a positive direction. There are many puts and takes. And internationally, there are parts of the world where inflation is more rapid than other parts of the world, a little bit more conservative in terms of investing in the business. But overall, the international business is also quite stable. And again, on the higher end of specialty products, I would say, it's probably global. There's more thinking of lower-priced product, procedures have not really come down. It's more in terms of watching for the price of the per unit that is used in the practice. The equipment is pretty strong. Traditional equipment is strong around the world. Digital equipment, particularly on the sensors, DI is under price pressure, but the units are growing, and I can get into more details on that. But generally, it's more stable. It's quite stable and more [ partisan ], I would say, in North America, which is about 2/3 of our business, a little bit more than that. And there are pockets of international that have challenges.

Okay. And then are you seeing anything at the [ clinic ] level from a macro perspective, like the staffing challenges that we had noted before? Like what's ongoing? Has some of that recovered or where are we at now?

On the dental side, there are still parts of the country where it's a challenge. Look, the big cities, take New York, people want to work here. You take some of the rural areas, there's a challenge in getting dentists. This has been the case for a while. I would say, it's particularly noticed amongst some of these larger DSOs that are opening up de novo practices, and they need to find people. They generally get through it. Productivity is growing in the practice because of digitalization, including the clinical workflow improvement and, of course, the practice management systems that are driving productivity. But there is definitely a shortage in dental hygienists. Dentists would like to move more of the procedures to the hygienist. And the hygienists have not come back in the numbers that we had before COVID. But from a Henry Schein point of view, our preventative business is important to us, but it's a relatively small part of the pie.

And let's dig into the dental equipment trends. I think you had 6% growth in the second quarter. That was encouraging. But can you parse out a little bit the traditional versus high-tech equipment, what you're seeing there, which you spoke briefly about? Like some of the key drivers, maybe in the most recent quarter? What's the sustainability of demand trends? What you're seeing in terms of investment in the practice and the overall [ environment ]?

I'm not sure exactly what we are providing in terms of information. I'll have Ron provide the specifics, if it's okay with you, Ron. But generally, the trends are, conceptually, as I noted, investing in traditional chairs, units and lights has been good throughout the world. We had a challenge at one point in obtaining all the production we needed. But we've got it. There are parts of the world, we've got it now, where we've had market shifts from one manufacturer to another. I would say that our customers are more tuned to price today than ever before, primarily, I would say, from the information available on the Internet. And they will shop one brand versus another, so we've had shifts from one brand on the traditional side to another. But generally, the traditional side is pretty good. On the digital side, as I noted earlier on, the prices have come down -- not so much price on a particular manufacturer. Have they reduced their price significantly? Not really, but there is a shift to manufacturers that are lower priced than the marketplace. There's some relatively new entrants into the market on the digital side. And we've seen competition amongst the manufacturers. On the digital milling side, there is, of course, a business that is occurring, but there's some questioning of whether it's a good idea to invest chairside in milling versus looking at a 3D printer. 3D printers have advanced. I think we're today the largest provider of 3D printers in the world. But they don't cover everything at this stage, not the front of the mouth from a cosmetic point of view. So you still need the mill, digital chairside mill, and the labs are doing well. We are the largest provider of dental lab products in the world. That business is growing nicely as it moves towards the digital side. But generally, it's a good solid market with some activity going on in the digital space. Units are there, pricing is moving around. And generally, we're talking about mid-single-digit growth. I mean, our growth has been a lot higher. But we think mid-single-digit growth going forward in the equipment side, with quarters where it will go higher, to be sort of where we are pegging our thinking. Ron, I don't know what additional information we are providing.

Well, I do think that now more than ever, we're really looking at that equipment category as 2 subcategories. The traditional is growing much, much, from a revenue base standpoint, has grown. Especially in North America, we're seeing double-digit growth in standard equipment. So the chairs, units and lights, which is really representative of, I think some optimism in our markets of adding on shares to the practices, is quite good. That's without the backlog really moving probably at all during the year. And we'd actually like to see that backlog come down a little bit. I think some people view the backlog coming down as a negative when in fact, we see it as a positive. We'd like to see that. For one, we'll get the additional revenue from it. But also, it means, I think, a greater capacity in our customers' practices as we get more chairs into their practices. And then in turn, they can see that many more patients and ensure that much more merchandise that they buy from us as well. High tech, as Stanley touched on, a little bit of disruption there. Some in the form of pricing on scanners, some just in the introduction of new products as 3D printers become more prevalent and what does that mean in terms of the effect on chairside mills, et cetera. I think the industry kind of stepped back from this a little bit, trying to figure out where they want to invest and I think as they understand better the scope or the applications that they can get from a 3D printer. Are these 2, a chairside mill and a 3D printer, do you want both in your practice? Do you want one and remove another? And I think some of that decision making is still going on.

Just -- thanks, Ron. Just a tad of caution. I'm not talking about this quarter going forth, any particular quarter. I think it's important in the equipment side to aggregate 3 or 4 quarters because we do a lot of business with DSOs, and we can have a significant shipment to a DSO of say sensors in a particular quarter as we had in the past quarter. And so one has to, when you look at specific categories, try to aggregate a few quarters and come up with an average.

On that note, I guess, how should we be thinking about the ordering patterns, the backlog into the next couple of quarters here? Is there something that we should be aware of from a volatility standpoint across that equipment book?

Well, I think -- and Stanley touched on this earlier, I do expect the demand for standard equipment to kind of level off in that kind of mid-single-digit range, mid- to high-single digit perhaps. Revenues though could exceed that as we work that backlog down, right? So as the order flow slows, we're still going to get fairly good revenue growth because we'll be able to work that backlog down a little bit.

Okay. Specialty, your business mix has evolved considerably over the past several years. And now over 1/3 of EBIT associated with some of those faster-growing, higher-margin businesses, particularly in tech and specialty. Where does that mix go over time? And what's going to -- what does that mix look like also? What does it look like now? And what could it look like longer term? What are the areas to potentially invest more?

Yes. So we do business with a significant number of dentists, GPs and specialists throughout the world. Our goal is to advance our specialty businesses, oral surgery, endodontics, orthodontics, within our customer base. We indicated at our Investor Day that we expect the profits from operating income from the specialty businesses. That's the products and also the services with the core service being Henry Schein One, but there are also other services as well. We expect that to -- about 2024 to be about 40% of our operating income. We feel, we say this on our calls, that we will get to that number sooner. Our business in that area, from an organic and inorganic point of view, is growing very nicely. And we expect these high-growth, high-margin profits to move towards the 50% mark in the next few years. So -- and that, of course, excludes our own private brand products, which are about 9% or 10% of our sales in the aggregate, and of certain product categories, obviously higher. We don't have our own private brand pharmaceutical product line for medical. We do not have our own private brand or corporate brand equipment line. So it's quite nice as a percentage of our profits in the specifically consumable area. So if you add that and the specialty products and services, you'll see that a nice percentage of our profits is now coming from brands that we control. Of course, we will always be focused. And we are, in most instances, the #1 distributor of national brand products, but we're focused on our own brands. And when national brand suppliers work with us, of course, we'll advance their sales.

And can you talk a little bit about implants? What you're seeing across your implant business, the strategy you have in implants, your recent S.I.N. acquisition as well, how that's progressing?

So implants, we have 2 very important markets. One is we believe we're the #1 player certainly in units, but probably in sales in Germany. Very important implant market, perhaps one of the highest penetrated markets, where we continue to gain market share. Likewise in North America, we are not in the top one or 2 or 3. At the moment, certainly not one or 2. And our goal is to grow. And then we have all the other markets around the world. In all markets but Germany, we essentially have been focused on the higher end of the market, the premier brands. We do not have a discount brand, except for Germany, so we have invested in 2 businesses, S.I.N. and Biotech, which give us access to the more economic branded products. And we expect to gain market share because, for example, if you just look at the U.S., we just do not have access to a lower-priced implant. S.I.N. will give us that. Their products are registered in the U.S. We already have a DSO, very quickly, that is using their implants. And so I think the portfolio will, of course, continue to grow on the premium side. And we have the premium products with just, I would say, a little bit lower price than our competitors. But it's the economic brands, the economy brands, that we wish to grow our business and specifically give the DSOs a very good opportunity to do more business with Henry Schein. And it's implants and bone regeneration products.

Thanks. You offered us a good glimpse of sort of your long-term targets at your first Investor Day, I think, since -- in a decade since you had one. Calling for 6% to 8% top line growth, including M&A, as well as 8% to 11% EPS growth on an adjusted basis. Can you talk about the key components of that growth from a dental and medical as well as technology perspective and your visibility sort of on that growth? And what would be deviations from that, particularly as we head into kind of 2024?

Certainly. And I think that when you look at the -- you mentioned the 6% to 8% top line growth that we kind of see as the long-term trend, and that assumed market growth in the dental industry of about 2% to 4%. That -- I think right now, we're probably trending to something at the high end of that. And I think some of that comes from some of the equipment growth we were talking about for standard equipment growth. Specialty, we were assuming market growth of 5% to 8%. We're probably trending mid to the low end of that range given the -- a little bit of the softness that we've talked about on the end market for implants, but there's still good growth there. And they're still -- we're obviously very bullish on the implant market, given the investments we've done there. So we still see a long-term trend that can be very favorable on the specialty side. And our endo line has done very well this year. It's really had consistent kind of high single-digit growth this year as well. When you look at medical, at least within the subsegment of medical in which we operate, about 4% to 7% was the market growth assumption. This year, for us, we are -- we're seeing that market probably trending towards the low end of that. Last year, we benefited greatly from -- I hate to put it this way, we benefited greatly from a strong flu season that actually resulted in very high levels of traffic into the physician office and also put a significant demand on point-of-care diagnostic kits that is difficult for us to repeat this year. So last year, when we had double-digit growth in our medical business when excluding PPE and COVID test kits, this year, that growth has been more kind of in the low to mid-single digits for our medical team. And then the last piece was our technology and value-added services assumption was that, that market could grow 8% to 12%. And I think that's still a good range. I think we're seeing that market grow towards the middle of that range, and we feel like we have a great opportunity there, not just because of the market growth, but we think there's a great opportunity for us to increase share of wallet with our existing customers in our technology business as well. But there's significant opportunities for us to expand our product offering, not just expand our product offering but to educate our customers as to what those product offerings are beyond kind of the core practice management system that they may be using. So I think our assumptions hold fairly well within all of those ranges in terms of what's the market doing, what's our -- how are we gaining any additional market share beyond that market growth. And we're -- we still think those are fairly sound assumptions for -- on a long-term basis.

And as you think about that 6% to 8% top line growth includes M&A.

Yes, it does.

But when you give 2024 guidance, you will not be embedding incremental M&A that hasn't been announced, right? So you would be below that by about 200 basis points?

Well, we'd be able to show -- just as we did this year and I think for '22 as well, when we talk about top line growth, we have provided some of the components of that growth, right? So we'll disclose what our estimates are of our '24 growth that's coming from the '23 acquisitions that we do.

I think what is important to understand, the more we invest in high-growth, high-margin products or businesses, the better it is for our bottom line. But they can get lost in the top line because you take the 2 major acquisitions we made on implants, very little top -- relative top line, important top line to our specialty business but very little top line impact for Henry Schein, in general, but significant operating income impact in the shift towards these high-growth, high-margin products.

And I think that kind of -- that's already manifesting itself a little bit now in our P&L. I mean the geography of that P&L is a little different than it used to be, right? If you look at -- and this is in our 10-Q, if you look at our second quarter 10-Q, that health care distribution segment, so that's taking technology out of it, that's taking Henry Schein One out of it. That health care distribution segment, for the 6 months -- for the first 6 months of the year, has $73 million less revenue than the prior year, and that's primarily due to COVID test kits and PPE. But when you look at the gross profit dollars coming from that segment, it's equal to the prior year. So we've absorbed a $73 million decrease in revenues to deliver the same gross profit in that segment. And that's really the result of a greater mix of the specialty products, which have better margin, as well as an ongoing slight shift towards our private-label products, which are going to have lower dollars but better gross profit dollars for us. So you're beginning to see some of that shift and it begins to change that geography of the P&L, so to speak, going forward.

And so when we think about PPE, COVID test kits, some of those dynamics that are impacting you, so this year, what continues into 2024? What should we be aware of?

There's still going to be a headwind there on PPE, for example. Our second quarter revenues on PPE were down -- I think it was 29% versus the prior year, but they were only down 8% versus the first quarter. So the sequential decline is beginning to become more and more diminished. So we're still going to hit -- go into '24 with PPE at a lower price point on gloves than the average price was over the course of '23, which is an inherent headwind, but it's not going to be nearly as pronounced as it was for '23 versus '22 or '22 versus '21.

Okay. And since we were talking about capital deployment, can you discuss a little bit of the priorities at this point? Has anything changed? M&A versus internal investments or buybacks? And give us an update on the pipeline, what you're seeing. Is it stronger than it was a year ago? Is it the same? Or how are you thinking about execution on sort of the M&A front? Is there a bigger deal ahead? Or is it smaller things and done from certain markets?

Yes. So in terms of capital deployment, historically, we've done $300 million to $400 million in M&A, $300 million to $400 million in share repurchases. I think that this year, we've committed over $1 billion of M&A. So obviously, we've been working through that pipeline. There are still transactions. There's always transactions in the pipeline. But my expectations are when we get into next year, we'll be kind of regressing back to something that's more to that $300 million to $400 million that we have done traditionally. But we're still going to be opportunistic as we look at M&A. This happened to be a year where there was -- we had -- we were fortunate in that we had a balance sheet that allowed us to take on some extra leverage, so that we -- when a lot of good opportunities came our way, we were able to take advantage of those opportunities and make the investments. But I don't -- I think this year is more of an anomaly in terms of $1 billion in M&A. We were committed to the share repurchase program, and we'll continue to do $300 million to $400 million in share repurchases in the near future.

And then you recently affirmed the top line guidance of 1% to 3% top line or can you discuss a little bit about price versus volume? What you're seeing there? What's normal? How should we think about that going into [ 2024 ]?

Yes. When you break down the components of that 1% to 3% revenue growth, about 4% to 7% is actually kind of core business because -- when you strip out kind of PPE, COVID test kits. Last year, we had the 53rd week and when you kind of normalize for all those things, we're looking at 4% to 7% of revenue growth on core business. And roughly, it's probably around a 50-50 effect of price versus volume that's providing us with that revenue growth. I think we're seeing now a more business as usual type of pricing environment from our suppliers. That's also being passed on to our customers. So I think it's more back to what you had seen or we had experienced in terms of price increases year-over-year as opposed to '22 versus '21 was a little more of an anomaly than what we're seeing, historically.

There's a more, I'd say, a much educated dental, [ in particular ], who's been on the medical side customer, that is thinking about moving from one brand to another, even looking at private brand, if they can find similar products at a better price. So that can certainly impact the per unit price but certainly doesn't impact the units and not our profit at all because these lower-priced products tend to come from manufacturers that are giving us a higher margin.

And lastly, just utilization has been a key topic in broader health care services arena. And I just want to ask on medical, what you're seeing in terms of utilization trends? And I know you're only in certain sites and not across the board, but if you could speak a little bit to utilization trends, excluding kind of some of the COVID dynamic.

Yes. If you take -- exactly. If you take out the COVID dynamics and you take out the impact, as Ron noted earlier on, of the heavy flu season last year, the movement from the acute care setting to the physician setting to the urgicenter to the surgery center is quite marked. It's moving. And of course, the home is also growing significantly.

Okay. Great. Thank you so much. I appreciate the time and yes, I hope you have a great meeting.

Thank you.

Very good. Thank you, Erin.